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Morningstar | CMB’s Funding Costs Advantage and Leadership in Asset Management Remained Largely Intact

Narrow-moat China Merchants Bank's, or CMB's, first-half results were in line with its preliminary announcement, with net profits increasing 14% from the year-ago period and accounting for 54% of our full-year projection. We retain our CNY 26 fair value estimate for A shares while reducing our fair value estimate for H-shares to HKD 30 to reflect the latest Chinese yuan/Hong Kong dollar exchange rate. The results reaffirmed our view that CMB's deposit advantage remained largely intact, despite rising competition and pace of new customer acquisition showed signs of acceleration, fueled by increasing technology adoption. Boosted by mild expansion in net interest margin, or NIM, and a rebound in fee income growth, CMB's ROE and ROA have steadily improved since mid-2017. ROE and ROA have expanded to industry-leading levels of 19.6% and 1.39%, respectively, in mid-2018. Its H-shares are fairly valued and CMB has been trading at valuation premium against large banks including ICBC and CCB, thanks to its faster-than-peer growth in shareholders' equity growth. Book value per share rose 4.6% from 2017, and we now expect full-year growth at around 12%, higher than the 7% to 10% range for the big four banks. Leveraging its premium customer base, CMB will continue to lead the industry in asset quality improvement and transformation in retail banking but we believe the upsides are factored in.

Strong recovery in fee income growth was another spotlight of the results, with growth in asset management-related fee income better than our expectation. Year-on-year growth in the second quarter total revenue growth accelerated to 16% from 7% in the first quarter, led by a pickup in fee income growth to 15% versus 1.5% and net interest income growth steady at 8.6%. Representing 20% of total fee income, credit card fee income grew 25% on a 41% year-on-year growth in card transaction volume. The 2% growth in asset management-related fee income, which represents 51% of total fee income, was better than our expectation. Though bank wealth management products', or WMP, related fee income saw a 11% contraction on a 4% decline in outstanding bank WMP, this was more than offset by the strong growth in agency sales of other alternatives including funds, trust, and insurance products. However, we expect such strong growth momentum of agency sales will gradually ease off in the second half given weakening market sentiment.

Net interest margin, or NIM, expanded 11 basis points to 2.54% from 2.43% in the year-ago period, with second-quarter NIM increasing 2 basis points from the previous quarter. Management expect relatively steady NIM in the second half as the bank will adjust its balance sheet structure including increasing tax-exempted local government bond investment, prudently increasing credit allocation to retail loans, reducing structure deposits and increasing interbank deposit certificates to take advantage of changing interest rate environment. Backed by resilient deposit growth and high proportion of demand deposits, CMB's average funding costs merely grew 21 basis points. Average asset yield rose 32 basis points as the bank increased credit allocations to discounted bank notes, lending to key strategic corporate customers and retail borrowers.

Credit quality has stabilized as bad debt ratio fell to 1.43% from 1.61% in 2017. Provision coverage increased to 316% from 262% as credit costs reach 1.7%. Though bad debt formation rate continued to trend down, special-mentioned loans and overdue loans increased 2% and 3%, respectively, from 2017, versus the negative growth in 2017. We believe this was due to growing risks in credit card loans on defaults on P2P platforms and corporate loans to trade-related sectors, which also contributed to slowing growth in the above-mentioned loan categories for the first half.